Introduction
The Global Financial Crisis (GFC) triggered unprecedented policy interventions in the crisis-affected
advanced economies. Major central banks reduced policy interest rates to close to zero and
implemented unconventional monetary policies such as massive injections of liquidity through
quantitative easing (QE). These measures have had a significant spillover impact on global economic
and financial conditions. To some extent, these policies have contributed to stabilising financial
conditions and supporting the recovery that is gaining momentum in these economies. While the
avoidance of a more severe global economic recession has benefitted the emerging economies,
there were unintended consequences from maintaining such policies for an extended period of
time, particularly, large capital inflows into many emerging economies in search for higher yields.
As economic recovery in the advanced economies becomes more entrenched, policymakers will
eventually need to unwind these unprecedented injections of liquidity to achieve more normal
monetary conditions. This transition, nevertheless, is likely to have an impact on the rest of the
world through various channels and in varying degrees. This article explores the spillovers of QE on
Asia and assesses the region’s strengths and vulnerabilities in facing the challenges that will emerge
from the reversal of the unconventional monetary policy measures by the advanced economies.
MONETARY AND FINANCIAL CONDITIONS
Spillovers of Quantitative Easing on Asia
Impact of QE on Asia
The introduction of QE has led to a massive injection of liquidity into the financial systems of the
advanced economies. The balance sheet of the Federal Reserve (Fed), for instance, grew by about
four times between December 2006 and August 2013. The balance sheet of the Bank of England
expanded by six times, while those of the European Central Bank and the Bank of Japan doubled.
Cumulatively, global liquidity, as proxied by the GDP-weighted M2 of the US, euro area, Japan and
the UK, increased from USD7.3 trillion in the third quarter of 2008 to about USD10 trillion in the first
quarter of 2013. The massive build-up of liquidity and the search for yields caused large capital inflows
into the emerging economies given their more favourable growth prospects and higher rates of return.
Between 2009 and 2013, Asia received portfolio inflows amounting to USD597.7 billion, equivalent to
2.4% of its combined GDP1 (Chart 1).
Chart 1
Impact of Quantitative Easing on Asia
Cumulative net foreign portfolio flows,
Q1 2009 - Q1 2013
Korea
146.2
PR China
145.8
India
100.3
Malaysia
71.9
Indonesia
49.6
Thailand
33.5
Chinese Taipei
21.5
Philippines
USD billion
9.8
0
50
100
150
Source: Haver and National Authorities
1
Asia includes Chinese Taipei, India, Indonesia, Korea, Malaysia, Philippines, PR China, Singapore and Thailand.
41
1
Singapore
ANNUAL REPORT 2013
19.1
MONETARY AND FINANCIAL CONDITIONS
This surge in capital inflows exerted significant upward pressure in the currency, equity and bond
markets of these Asian economies (Chart 2). The decline in bond yields, in tandem with that of the advanced
economies, contributed to a reduction in the domestic cost of financing. The lower interest rate environment
and ample liquidity conditions may have contributed to the underpricing of risks, thereby encouraging
excessive investments in risky assets and led to the build-up of financial imbalances. As a result, several Asian
economies experienced high credit growth and rising property prices.
Chart 2
Impact of QE on Asian Currencies and Financial Markets
Performance against US dollar,
1 April 2009 - 21 May 2013
KRW
Equity performance,
1 April 2009 - 21 May 2013
TH
24.7
SGD
21.1
PH
MYR
21.1
ID
THB
19.5
IDR
18.7
PHP
-10
0
10
20
30
261.8
KR
IN
MY
104.8
MY
CN
%
PH
107.2
-100
64.2
TW
60.9
SG
CN
-2.9
0
100
-501
-353
-275
-191
-166
TH
102.6
TW
11.5
INR -7.3
ID
268.9
IN
KR
13.9
CNY
280.9
SG
17.6
TWD
Change in spread between 10-year Government
bond yields and policy rates,
1 April 2009 - 21 May 2013
200
300
%
-130
-86
-51
-42
basis points
-600
-400
-200
0
Source: Bloomberg and Bank Negara Malaysia
As the recovery in the advanced economies gains momentum, the unconventional policies and
the highly accommodative monetary conditions will be gradually unwound. The transition, if not
managed properly, could lead to sudden and sharp reversals of capital flows from the emerging
economies, which would in turn trigger disruptions in the global financial markets and affect the
pace of global recovery. This was evident in May 2013 following the initial indication of a potential
QE scale-back. Uncertainty over the timing and magnitude of the QE scale-back, coupled with the
rising expectations of narrowing interest rate differentials between the advanced and emerging
economies, prompted investors to rebalance their portfolio position and rapidly unwind their
investment positions in the emerging economies. Large capital outflows led to significant downward
pressure on currencies and prices in equity and bond markets in the emerging economies between
May and August 2013 (Chart 3). In some markets, the reversals caused excessive fluctuation in the
bond and equity markets, and overshooting in the exchange rates.
ANNUAL REPORT 2013
In contrast, the Fed’s announcement to begin reducing the pace of asset purchases in December 2013
initially had a more limited impact across economies, as investors had already built in the expectations
of an eventual scale back in QE. The enhanced forward guidance in the December FOMC statement
had realigned market expectations of the timing of the Fed’s first rate hike to a later period. However, the
December 2013 decision only marks the beginning of the policy transition in the US. Indications are that
the path towards normalisation of monetary policy is expected to be gradual and would take place over
a period of time, as well as being conditioned by the strength of the economic recovery. During this
transition, the emerging economies will operate in a highly uncertain environment with frequent sharp
increases in volatility in the financial markets as investors reassess and shift their positions. In the early
part of 2014, volatility in the international financial markets has risen with several emerging economies
being severely affected by massive capital outflows. It is also evident that there has been greater
differentiation between emerging economies, as investors scrutinise the fundamentals of each country.
The risk of contagion, nevertheless, still remains and is on the rise.
42
2
Impact of Potential Scaling-back of QE on Asian Currencies and Financial Markets
Performance against US dollar,
22 May - 28 August 2013
Equity performance,
22 May - 28 August 2013
INR -18.3
IDR
-10.8
MYR
-7.9
PHP
-7.9
SGD
-0.6
KRW
-22.4
IN
-21.7
-0.5
TH
-5
25
5
-5.7
-4.9
20
15
10
69
CN
-6.7
KR %
82
KR
-8.8
MY
0
129
124
MY
-10.5
TW
0.2 %
247
161
SG
-12.8
CN
CNY
-10
ID
ID
IN
TWD
-15
-22.4
SG
-2.2
-20
TH
PH
-9.7
THB
Change in spread between 10-year Government
bond yields and policy rates,
22 May - 28 August 2013
5
58
TW
41
PH
38
0
0
50
MONETARY AND FINANCIAL CONDITIONS
Chart 3
basis points
100
150
200
250
300
Source: Bloomberg and Bank Negara Malaysia
Asia’s challenges and policy responses
While Asia is in a better position relative to the period prior to the Asian Financial Crisis (AFC),
recent developments have highlighted the key challenges faced by the emerging economies in an
environment of highly volatile capital flows. These include the sustainability of external positions,
adequacy of policy space and the health of domestic balance sheets. In particular, countries that
have twin deficits are judged to be more reliant on short-term funding and vulnerable to capital
reversals (Chart 4). While the narrowing of the emerging economies’ current account surplus post-GFC
was initially welcomed as a sign of global rebalancing, it has subsequently been seen as increasing
the likelihood of potential funding stress if the economies rely heavily on external short-term flows.
Chart 4
Exchange Rate and Bond Yield Movements versus
Current Account Balances
Exchange rate movement (%, end-May to end-August 2013)
8
Appreciation
4
PR China
0
Korea
Chinese Taipei
-4 Philippines
Thailand
-8
Indonesia
India
-6.0
Malaysia
-12
-4.0
-2.0
-16
0.0
2.0
4.0
6.0
8.0
10.0
12.0
Current account balance (% of GDP, 1H 2013)
Bond yield movement (ppt increase, end-May to end-August 2013)
Thailand
2
PR China
India
Malaysia
0
Philippines
-2
-6.0
-4.0
-2.0
0.0
2.0
Current account balance (% of GDP, 1H 2013)
Source: Bloomberg and Haver
Korea
4.0
6.0
43
3
Indonesia
ANNUAL REPORT 2013
4
MONETARY AND FINANCIAL CONDITIONS
Widening fiscal deficits and high public debt following large stimulus measures during the GFC raised
concerns over the increase in debt servicing costs and the adequacy of fiscal space to embark on future
counter-cyclical policies. Another concern is that rapid capital outflows could lead to sharp declines in
asset prices with serious repercussions on household balance sheets.
The policy responses by Asian policymakers in addressing the challenges that have been highlighted
can be segregated into two phases. Post-GFC, household balance sheet had been a core policy
concern. Hence, policymakers in Asia have, since 2009, progressively implemented policies to tackle
rising household indebtedness. In particular, countries such as Hong Kong SAR, Singapore and
Malaysia have adopted pre-emptive measures including the implementation of macroprudential and
demand management policies to address potential overheating in the property market and to slow
the growth of credit. Beginning in 2013, the policy focus in several Asian countries has been extended
to address the issue of twin deficits. These countries introduced a series of policies which included
easing of export rules and improved management of foreign exchange liquidity to strengthen their
external positions. In several economies, policy rates have been raised. Fiscal consolidation plans,
including tax reforms and subsidy rationalisation, are also being used to restore the health of the
government balance sheet. The credibility of these plans has been reinforced by the commitment of
clear milestones for fiscal targets in the short and medium term.
Building greater resilience against external shocks
Beyond these immediate challenges, proactive efforts have been undertaken in the recent years to
ensure that capital inflows and their subsequent reversal do not significantly disrupt the domestic
financial system and economic activity. This has been complemented by structural reforms that have
been steadily rolled out since the AFC to increase the resilience of economies, both at the national
and regional level.
The strength in the emerging economies’ growth in the five years after the GFC has been
supported by more diversified sources of growth. In particular, Asia’s domestic demand
accounted for 86% of GDP in 2012 (1990: 81%). At the same time, regional economies have
diversified their trade partners, with intra-regional trade accounting for close to 50% of total
trade in 2012 (1990: 37%). Asia’s resilience has also been enhanced by more flexible exchange
rate regimes, as well as more developed and stronger financial sectors. Compared to the pre-AFC
period, most Asian economies are now less reliant on short-term debt funding, have expanded
the sources of funding for the economy and have higher level of foreign exchange reserves. In
addition, the quality of foreign debt funding has also improved given the deeper and broader
capital markets in many countries in the region. These have significantly improved the resilience
of Asia in withstanding and responding to external shocks and safeguarding domestic financial
and macroeconomic stability.
ANNUAL REPORT 2013
In addition, there is now greater regional financial integration and cooperation. Over the past
decade, regional initiatives have been strengthened to provide a much stronger framework for
cross-border financial assistance to improve the crisis readiness of the region. This includes the
enhancement of multilateral liquidity support among the Asian economies, such as the Chiang Mai
Initiative Multilateralisation (CMIM), which is complemented by economic surveillance conducted
by the ASEAN+3 Macroeconomic Research Office (AMRO) and Monetary and Financial Stability
Committee of the Executives’ Meeting of East Asia-Pacific Central Banks (EMEAP). The recently
enhanced Crisis Management and Resolution Framework among EMEAP member countries
also serves as a mechanism for collective policy response, surveillance and information sharing.
New financial arrangements to facilitate trade financing and settlement in domestic currencies,
primarily through local currency swap arrangements between regional central banks have also
added a degree of resilience as these have reduced the vulnerability of regional trade to global
financial market volatility.
44
4
MONETARY AND FINANCIAL CONDITIONS
ANNUAL REPORT 2013
45
5
Conclusion
The implementation of unconventional monetary stimulus in the advanced economies was premised
upon achieving domestic policy objectives but has had wide-ranging global spillovers. As the
pace of economic recovery in the advanced economies gains momentum, the shift towards policy
normalisation will eventually take place. This shift will have implications for global capital flows,
in particular through the rebalancing of portfolio flows from the emerging economies back to the
advanced economies. Against this backdrop, policymakers in Asia face the challenge of managing the
impact of capital flow reversals on their domestic economic and financial conditions. Asia, as a whole,
has exhibited greater resilience than in previous decades, reflecting in part, the dividends from the
post-AFC reforms. In addition, a broader and enhanced policy toolkit will help manage the potential
negative externalities that may arise. All these will not necessarily insulate the Asian economies from
the spillover effects from policy normalisation in the advanced economies. However, pre-emptive
response will enable Asia to alleviate some of these effects and maintain the resilience of the region.